Introduction

Hi everyone, Anton with IntellCRE here. In this video, we’re going to look at the importance of sensitivity analysis, or in other words stress testing our analysis with respect to the most crucial assumptions that we’re making. We’re also going to look at how you can work with and implement sensitivity analysis within the Intel CR platform easily.

Key Underwriting Assumptions

To begin, I’m going to open up the analysis form for this property.

Some of the most crucial assumptions that we’re making when underwriting a deal are assumptions around the proforma rents, assumptions around the proforma rent growth, or in other words how our rents are going to grow year over year projected into the future.

We’re also making very crucial assumptions in the value and financing section, in particular in the acquisition and sale assumptions.

These include what the hold term for the project is going to be, what the purchase price for the property is going to be, and what the exit cap rate is going to be.

Why Exit Cap Rate Matters

The exit cap rate, together with the NOI in the last year of the hold term, is probably the most important assumption in the entire underwriting.

This is because the exit cap rate together with the NOI in the final year determines the exit value of the property, or in other words, what the sale proceeds are going to be once we sell the property at the end of the hold term. Of course, that’s where most of the money is made.

Even a slight variation in these assumptions, caused by market cycles, shifts in demand, or other external factors, can change an otherwise great deal into an average deal or even a bad one.

That’s why it’s very important to use the sensitivity analysis tools available in the Intel CR platform for every underwriting we do.

Accessing Sensitivity Analysis

Let’s now look at how we can do that.

Below the property value estimates and below our financing section, we have a sensitivity analysis button.

When we press that button, we see four sensitivity analyses that we can enable:

• Exit cap rate sensitivity

• Purchase price sensitivity

• Proforma rent growth sensitivity

• Hold term sensitivity

These are four of the most important assumptions in the entire underwriting.

Exit Cap Rate Sensitivity

Once we enable these, we can choose how many steps we want.

To explain this, I’ll navigate to the bottom of the screen, click on the sensitivity analysis tab, and roll up the bottom panel.

We’ll start with the exit cap rate sensitivity.

The number of steps represents how many different scenarios we want to analyze. In this case, seven.

The middle scenario shows the current assumption in our underwriting. In our sale assumptions, the exit cap rate is set at 4.79, so that’s the middle column.

Below that, we see the exit value, which is the price of the property once we sell it at the end of the seven-year hold term.

Below that, we see the IRR, which is the internal rate of return, and below that the equity multiple.

Adjusting Exit Cap Rate Increments

We can also set the increment.

If we set the increment to 0.1, we see that as we move to the left, the exit cap rate is lowered by 0.1 percent increments. With lower cap rates, the exit value increases, and as a result, IRR and equity multiple improve.

As we move to the right from the middle column, the opposite happens. The cap rate increases in 0.1 percent increments, the exit value decreases, and so do the return metrics.

Purchase Price Sensitivity

The same structure applies to purchase price sensitivity.

Let’s set the purchase price step to $150,000 and click on the purchase price sensitivity tab.

In the middle column, we see the purchase price we entered. As we move to the left, the purchase price is reduced by $150,000 increments, and the return metrics improve because we’re buying the deal at a lower price.

As we move to the right, the purchase price increases and the return metrics decrease.

Proforma Rent Growth Sensitivity

Next is the proforma rent growth sensitivity.

Here, the step is set to 0.5.

When we switch to the proforma rent growth tab, the middle column represents the current proforma rent growth assumption, which is 4 percent, along with the corresponding return metrics.

As we move to the left, lower proforma rent growth results in significantly lower returns. As we move to the right, higher proforma rent growth results in improved return metrics.

Hold Term Sensitivity

Finally, we have the hold term sensitivity, where the step is one year.

When we switch to the hold term sensitivity tab, we can see how the deal performs if we hold it for seven years, eight years, nine years, and so on.

As we move to the left, we can see how the deal performs with a shorter hold period.

Financing Considerations with Hold Term

With hold term sensitivity, we need to be careful when using financing.

If the hold term we’re analyzing is shorter than the loan term in our acquisition financing, we may need to pay off the loan before the end of the hold term. This results in a very large negative cash flow that gets factored into the analysis.

Make sure we’re never analyzing a hold term that conflicts with the loan term setup in our financing assumptions.

Using Sensitivity Analysis in Reports

That’s how you can use sensitivity analysis easily in the IntellCRE platform.

You can include this sensitivity analysis in all your deal reports, websites, and brochures to further justify the pricing you’ve determined to be optimal for the deal.

You can justify a lower or higher price to clients, partners, sellers, or buyers using the sensitivity analysis tools available within IntellCRE.

Conclusion

We hope you’ll find this video helpful, and we’ll see you in the next video.